Journal Issue

Country focus United Kingdom reaps benefits from strong reforms and sound policy frameworks

International Monetary Fund. External Relations Dept.
Published Date:
March 2005
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Over the past decade, U.K. economic growth has been steady and stronger than in most other major industrial countries thanks to the rigorous implementation of structural reforms, improvements in macroeconomic policies, and well-designed policy frameworks. The economy is operating at close to full capacity and is expected to continue growing at about 2½ percent a year, the IMF reported in its latest economic review.

Domestic demand remains the key driver of growth, underpinned by continued strong growth of real labor earnings and house prices, and robust corporate profitability. Unemployment has fallen to a 30-year low, nominal wage growth has been moderate, and inflation remains subdued. “The U.K. economy has benefited enormously from structural reforms during the 1980s that substantially increased flexibility, and the introduction in the late 1990s of clear and simple macroeconomic policy rules” said Susan Schadler, Deputy Director of the IMF’s European Department and mission chief to the United Kingdom. “In addition, a large fiscal adjustment in the late 1990s and other favorable developments, such as improving terms of trade and rising property prices, have bolstered performance.”

Uncertainties remain

The economy is well positioned to sustain growth over the medium term, but uncertainties and challenges born of the recent economic success remain. “The most immediate risks come from U.K.-specific factors—the widely perceived overvaluation of house prices, which could see an abrupt correction, and the potential for wage pressures in the context of low unemployment—as well as external influences such as a possible unwinding of global trade imbalances,” Schadler said. The housing market has recently cooled, and house prices are expected to decline modestly in 2005.

The U.K. fiscal position deteriorated sharply over the past five years, reflecting increased government spending to improve public services and declining revenues in the aftermath of the equity price bubble. Although the overall deficit is not unusually large compared with other major industrial countries and the debt burden is relatively low, “a persistent fiscal deficit at current levels over the next few years could undermine the credibility of the fiscal rules,” Schadler said. The U.K. Treasury projects that slower spending growth and a rebound in revenues will reverse this deterioration and ensure that the fiscal rules are respected now and in the future. Tom Scholar, the U.K. Executive Director, told the Board that “the current fiscal stance remains consistent with these rules and appropriate for this point in the economic cycle.”

However, the question remains about how much revenues will rebound in the absence of further policy measures, and during the IMF Executive Board discussion, many Directors saw the authorities’ projections as somewhat optimistic. The Board noted the authorities’ commitment to take measures should they prove necessary. However, many directors recommended that a mild fiscal adjustment be started expeditiously. “Early and gradual consolidation would then start in strong economic conditions, and the adjustment would appropriately be spread over time,” said James Morsink, Division Chief in the European Department. The fiscal policy framework—based on a golden rule (current balance or better over the cycle) and a debt ceiling—is one of the strongest among industrial countries. A review of the framework and consideration of ways to enhance it would be useful as the present cycle ends.

United Kingdom20012002200320042005
(percent change)
Real GDP2.
Domestic demand2.
Unemployment rate5.
(percent of GDP)
General government balance10.0-2.2-3.2-2.9-3.1
Public sector balance10.0-2.4-3.2-3.0-3.1
Public sector net debt131.032.333.735.437.1
Data: U.K. Office of National Statistics and HM Treasury; and IMF staff estimates.

The fiscal year begins in April. For example, fiscal balance data for 2002 refers to FY2002/03. Debt stock data refers to the end of the fiscal year.

Data: U.K. Office of National Statistics and HM Treasury; and IMF staff estimates.

The fiscal year begins in April. For example, fiscal balance data for 2002 refers to FY2002/03. Debt stock data refers to the end of the fiscal year.

Preparing for risks

In guarding against the risks, Morsink said “monetary policy needs to be prepared to react quickly to changes in inflationary pressures, either on the downside, for example, if housing prices fell sharply, or on the upside, if labor earnings began to accelerate.” The review concluded that monetary policy has been appropriate in recent years and is now well positioned to respond to shocks. The policy interest rate is in a neutral range and, given the uncertainties in the outlook, the next move in interest rates could be up or down. The Board and staff welcomed the increased emphasis on inflation projections based on market expectations of future interest rates and the extension of the projection horizon from two to three years.

Strong and steady

During 1995-2004, U.K. economic growth per capita was higher and more stable than in most other industrial countries.

Data: IMF, World Economic Outlook database.

The challenges of population aging, although less severe than in most other industrial countries, are also moving to the forefront of public debate in the United Kingdom. A recent interim report by the U.K. Pensions Commission concluded that many people are not saving enough for retirement, noting that about half of the working-age population over age 35 has inadequate savings to supplement the relatively minimal state pension. While staff and the authorities agreed on some aspects of the solution to this problem, particularly increasing the pensionable age, views differed widely on the appropriate role of the government in promoting private saving.

The Board welcomed the narrowing of the productivity gap between the United Kingdom and the average in other major industrial countries and encouraged the systematic evaluation of government initiatives to boost productivity. The authorities also intend to address structural rigidities in the housing market. Indicators of the health of the financial system remain quite favorable.

Copies of “United Kingdom: 2004 Article IV Consultation,” IMF Country Report 05/80, and “United Kingdom Selected Issues,” IMF Country Report No. 05/81, are available for $15.00 each from Publication Services (see page 80 for ordering details) or on the IMF’s website (

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